Sunday, November 16, 2008

Auto Bailout

I'm undecided on the auto bailout. At first I was opposed to it, because if there's anyone who has ever needed Chapter 11 bankruptcy, it's the Big Three. Their business model and their capital structure are both clearly unsustainable; they badly need to restructure, and that's what Chapter 11 is for. I'm still leaning heavily toward rejecting the auto bailout, but this, from Wilbur Ross (a.k.a. the King of Bankuptcy), has given me pause:

Investor Wilbur Ross, who made billions turning around distressed steel and textile companies, said a Chapter 11 filing by General Motors Corp. or another U.S. automaker wouldn't work and might devastate the economy. Going to court to reorganize would be "a very inhospitable environment for any of these guys," Ross, 70, said in an interview yesterday. "It would be a total mess." ... "If we were in a different overall economic environment, one of them going down wouldn't necessarily kill" the industry, he said. A weakened economy and frozen debt markets make an automaker bankruptcy impossible, with a Chapter 11 filing for reorganization resulting in liquidation instead, Ross said.
It isn't entirely clear why Ross thinks Chapter 11 would be impossible, but the lack of available financing seems to be his main concern. If that's the problem, then instead of lending the Big Three $25 billion to keep them out of Chapter 11, the government should let them file for Chapter 11 and then agree to provide DIP financing.


Anonymous said...

DIP financing while a major concern is the least of the worries in my opinion, a critical risk is that there is no guarantee that Chapter 11 does not change into Chapter 7.

I understand the argument from most conservative, free-market libertarians that automakers should be left alone to suffer the normal strictures of the market and file for bankruptcy like any normal company. Certainly, that would force management into an immediate and deep restructuring, closing plants and off-loading payroll faster than ever. It is the same thing that most major U.S. airlines have taken in recent years and most have emerged fitter for it. But here is the problem: flying on a bankrupt airline is one thing. The trip is over in a few hours. But who is going to buy a car from a company that is in bankruptcy? No one, if they care about servicing, parts and, above all, resale value. Moreover, Bankruptcy would also allow the company to tear up all its labor union contracts, but the resulting renegotiation could be messy.

The lesson learned from Lehman’s demise is that there are unpredictable secondary effects of failure. There are some 100k direct jobs on the line at GM and health care, including especially the pensioners, covers 10x more people and then there are over 1000 suppliers.

In a article posted on Bloomberg November 18th ‘Carmaker Failure Would Be Catastrophe, Wagoner Says’, the CEO of GM said that “3 million jobs would be lost within the first year, personal income would drop by $150 billion and government tax losses would total $156 billion over 3 years.”
In the same article it reported that Deutsche Bank released an economic note that said unemployment would immediately increase to 8 to 8.25% from the current 6.5% if the automakers default and GDP would shrink by at least 4%.

I personally am on the fence because it is hard to tell if the automakers are being truthful about the knock on effects or Paulson-Bernanke truthful.

Bloomberg Article: Carmaker Failure Would Be Catastrophe, Wagoner Says (John Hughes, Nov 19 2008)

Economics of Contempt said...

If that's the issue with the financing (and I suspect you're right), then Congress might want to consider promising the auto companies government money, but only after they emerge from Chapter 11. Of course, that doesn't solve the problems with servicing, parts, and resale value you mentioned, so maybe it would actually be better to give them the money up-front. Giving them the money up-front would keep them from restructuring in Chapter 11 though, so that money would have to come with a requirement that they restructure in a serious way (even if we don't formally call it "Chapter 11 bankruptcy").

Both our options in this case (i.e., saving them or letting them file for bankruptcy) are essentially rolls of the dice, which makes me uneasy. The last time we rolled the dice was with Lehman, and it came up snake-eyes.

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